What is a Price Level?

What is a Price Level?

Definition

The term price level refers to the average of current prices of the goods and services produced in an economy. It is the level at a specific point in time. The price level in the economy assumes significance because it is used to measure the rate of inflation.

What does price level mean?

Price levels are influenced by two factors. The first is a change in the supply of money and the second, an increase or decrease in the supply of goods and services.

Let us examine how these two elements can influence the price level:

⇨ Change in the supply of money – if the total of the goods and services in the economy remains constant and there is a greater amount of money in the hands of the people, the price level will rise. “Too much money chasing too few goods” will result in inflation.

⇨ Change in the supply of goods and services – if there is an increase in demand in the economy and the supply remains constant, the price level will rise. Conversely, a fall in demand could lead to a decrease in prices.

Of course, the price level usually changes because of both factors. There could be a change in the supply of money as well as a change in the supply of goods and services. If prices rise rapidly, a country’s central bank takes measures to control inflation. However, there could be times when the price level spirals out of control.

Example of price level

Here are some instances of extremely high inflation:

Germany in the post-World War I period – at the height of the inflationary period, price increases reached rates in excess of 30,000% per month. Why did that happen? The country printed a great deal of currency while the supply of goods remained low.

Hungary – the country witnessed a level of hyperinflation that is hard to imagine. At one point, in the post-World War II period, prices were doubling every 15 hours.

Venezuela – more recently, the South American country has been witnessing extremely high levels of inflation. This has been brought about by poor government policies and a fall in the price of oil, a major export. The International Monetary Fund (IMF) estimates that in 2018, the country will see an increase in price levels of over 2,349%.

Summary

The price level is a key economic indicator. It allows economists to measure the rate of inflation and provides central bankers with some of the key information that they need to frame the country’s monetary policy.